Longer-term interest rates have gone down rather than up and bond market volatility has remained low.
These are the culprits as the leaders of the largest United States banks lay the groundwork for poor earnings reports in the second quarter of 2014.
These banks have become so dependent upon trading revenues and other fee income that their "banking" results have become dominated by the activity in these areas.
Loan growth? That really receives only a passing comment any more.
For example, in the Wall Street Journal report by John Carney on what banks have been doing, we get the throw-away comment buried in the article: "…while loan growth once again failed to keep a similar pace (as deposit growth), at just 0.5 percent." That's all…
The big news, the biggest banks are giving guidance on a substantial drop in trading revenue for the second quarter.
This was backed up by comments by Daniel Pinto, head of investment banking at JPMorgan Chase (NYSE:JPM), who stated that "volatility levels were at 10- to 15-year lows."
Pinto argued that "If the market doesn't move, it's really difficult…" to make money.
According to another article by John Carney, "through the end of April, bond-trading volume had fallen 13.2 percent from the first four months of the prior year…. That puts this year on a path to be the lightest for trading since 2002."
Gary Cohn, President of Goldman Sachs Group, Inc. (NYSE:GS), has also confirmed that Goldman will also be hurt by the decline in trading volume. Whereas some other banks have responded to the decline in trading revenues by committing their organizations to further staff cuts, Mr. Cohn defended what Goldman has done, reducing its headcount by 10 percent since 2010, but argues that it will continue its strategy for trading pretty much as it is.
It is the "economic fundamentals" that is causing the results, he argues, and Goldman will continue to count on trading in the future, as the economic fundamentals improve. Mr. Cohn emphasized that "Goldman executives were (not) sitting around waiting for the upturn" and were seeing good results in "another less-well known part of the business: private wealth management."
Analysts say that Bank of America (NYSE:BAC) and Morgan Stanley (NYSE:MS) will not be hurt as much by the slow trading results because they are not into trading as much as these other banks or they have strategically changed their business significantly to shrink the impacts that trading has on their performance levels.
There are two concerns that come from the comments of these bank leaders. The first is a short-run concern and has to do with whether or not this reduction in volatility is just "temporary." And, if it is just "temporary," how long will the situation continue to last.
I believe that the recent movement in longer-term interest rates has surprised almost everyone. Yesterday, I wrote that the recent information on economic growth has caused participants in the bond markets to lower their expectations of the "real" rate of interest in the United States.
Today's announcement that the government's revised numbers showed that real Gross Domestic Product declined in first quarter of 2014 from the fourth quarter of 2013 just confirms the fact that economic growth may not be as robust in 2014 as analysts originally believed.
This will tend to keep these longer-term interest rates lower this year than many, including myself, had been forecasting.
And, as we have seen, as these interest rates remain at relatively low levels without much expectation of change, the volatility in the bond markets will also remain tame for a longer period of time.
That is, don't expect trading revenues in securities to pick up in the near term.
The second concern is a longer-run concern. The emphasis in these financial institutions on trading revenues evolved from the environment of credit inflation created by the federal government over the past fifty years. As credit inflation progressed, people/institutions took on more and more risk, increased their financial leverage, mismatched the maturities of their assets and liabilities, and engaged in financial innovation.
These large financial institutions began relying more and more on market volatility to generate fees and trading revenue. And, as they prospered because of this environment, this part of their business expanded. And, this expansion, to me, was not unlike the move of some large manufacturers to build financial organizations, some of which provided the industrial giants with more than 50 percent of their profits.
As these manufacturing firms have reduced their reliance on their financial divisions since the economic collapse known as the Great Recession, maybe these large banks need to reduce their reliance on market volatility and get back into other parts of their businesses that form more of a core of their operations.
I believe this subject will become more and more a part of the conversation about these large financial institutions in the future. Stay tuned.